Are Accruals Mispriced? Evidence from Sweden

Abstract: We investigate whether Sloan's (1996) accrual-based trading strategy extended with discretionary accrual measures could be applied to the Swedish market in 1998-2010. To increase the strength of our conclusions, we base our study on two alternative measures of discretionary accruals: the widely used Modified Jones (Dechow et al., 1995) and recently introduced Ibrahim (2009) models. Sloan shows that a strategy based on total accruals generates risk-adjusted return of 10.4% when applied to U.S. data between 1962 and 1991. Xie (2001) argues that this return is driven by component of accruals attributable to management discretion. We find that the strategy based on discretionary accruals is successful when applied to the portfolio of Swedish industrial companies: buying income-decreasing and short selling income-increasing companies generated risk-adjusted return of 14.4% before 2005. We find no mispricing when strategy is applied to Swedish market as a whole. However, this finding is contaminated by poor quality of discretionary accrual estimates in this sample. In addition to prior studies, we test how returns to the strategy changed over time and find no evidence of mispricing after IFRS was officially introduced in Sweden in 2005. Overall, our findings suggest that analysis of accruals could have been used to detect mispriced securities of manufacturing companies.